Learn why rising interest rates are disrupting earnings expectations for so many depositories!
Are your deposits misbehaving? Not as sticky and rate-insensitive as you thought they would be?
This is not unusual as banks, credit unions and their regulators are prone to believe that most, if not all, deposits are innately valuable, where values need only be quantified through a simple backward-looking, empirical exercise. This belief is particularly problematic today because the extended, low-rate environment of the post-crisis era in the US, in which massive amounts of liquidity flowed into the banking system and sat there, made deposits appear to be much stickier and less rate-sensitive than they really are. For depositories that failed to appreciate this anomalous behavior, rising rates have been a rude awakening. In Europe, where retail deposit rates have been zero (and alternative investments have had a negative yield) for even longer, reality will be even more painful when rates inevitably increase.
Announcing upcoming NMD Workshops:
In these workshops, I explain the critical role than deposits play in the assessment of interest rate risk, liquidity risk and corporate profitability. Against this backdrop, I demonstrate an approach to modeling NMDs which is uniquely designed to align the treatment of behaviors across risk AND profitability management domains. I demonstrate a conservative, risk-aware assumption-setting process and calibration of MMFTP methodologies which explicitly quantify the absolute and relative value proposition of each type of NMD. If behaviors (for which the product gathering business units are responsible) are realized, FTP spreads will be stable; this not only gives product managers a credible chance at delivering budgeted margins, but it also provides confidence around risk measures which are derived from the same assumptions. Alternatively, if anticipated behaviors are not being realized, FTP spreads will deviate from expectations and risk and business unit personnel will be compelled to re-calibrate their behavioral assumptions and any risk and profitability measures which derive from them.
In a recent presentation to a major US bank regulator, I was asked why I would inquire about a bank’s asset growth strategy when calibrating the behavioral model for NMDs. I pointed out that deposits don’t exist in a vacuum; they behave the way a bank (mis-)manages them. If a bank creates a situation where it must have funding, it will have to pay whatever it takes to steal deposits from another institution. Historical behaviors are likely to be irrelevant and potentially quite misleading.
If your firm’s claims about being asset-sensitive (or only slightly liability-sensitive) AND management’s projections for future earnings growth are to have any merit, it is imperative to recognize that deposits must be managed to maximize AND maintain their value. Absent clear and economically-robust product and compensation management strategies which explicitly acknowledge value-generating attributes, expected deposit values are not likely to be realized, especially in rising rate environments. For firms that do not measure and monitor these attributes, e.g. using properly-calibrated MMFTP methodologies, and hold deposit gatherers accountable for delivering those attributes, a naïve focus on deposit VOLUME is the only alternative, but beware – VOLUME and VALUE are not the same thing!
Is your firm ready for the impact of rising rates? Don’t let poorly-constructed assumptions around the largest source of balance sheet funding distort perceptions of risk and profitability!
For more information about the workshops, see NMD Workshop. I hope to see you there!
